{"id":263,"date":"2021-01-26T22:33:02","date_gmt":"2021-01-26T22:33:02","guid":{"rendered":"https:\/\/courses.lumenlearning.com\/wm-managerialaccounting\/?post_type=chapter&p=263"},"modified":"2021-05-23T01:00:06","modified_gmt":"2021-05-23T01:00:06","slug":"internal-rate-of-return","status":"publish","type":"chapter","link":"https:\/\/courses.lumenlearning.com\/suny-clinton-managerialaccounting\/chapter\/internal-rate-of-return\/","title":{"raw":"Introduction to Advanced Capital Budgeting Tools","rendered":"Introduction to Advanced Capital Budgeting Tools"},"content":{"raw":"

What you will learn to do: Use time value of money to analyze investment options<\/h2>\r\nLet\u2019s take a look at JuxtaPos again, but in this case, management is considering adding a line of puzzles that necessitates a new machine that will cost $230,000 with an estimated useful life of 6 years and a residual value of $40,000.\r\n\r\nEstimated net cash inflows are as follows:\r\n
\r\n\r\n\r\n\r\n\r\n\r\n\r\n\r\n\r\n\r\n\r\n\r\n
Description<\/th>\r\nAmount<\/th>\r\n<\/tr>\r\n<\/thead>\r\n
Year 1<\/td>\r\n$ \u00a0 \u00a0 \u00a0 \u00a0 60,000<\/td>\r\n<\/tr>\r\n
Year 2<\/td>\r\n\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 60,000<\/td>\r\n<\/tr>\r\n
Year 3<\/td>\r\n\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 55,000<\/td>\r\n<\/tr>\r\n
Year 4<\/td>\r\n\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 55,000<\/td>\r\n<\/tr>\r\n
Year 5<\/td>\r\n\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 50,000<\/td>\r\n<\/tr>\r\n
Year 6<\/td>\r\n\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 65,000<\/td>\r\n<\/tr>\r\n
<\/td>\r\nSingle Line<\/span>$ \u00a0 \u00a0 \u00a0  345,000Double line<\/span><\/td>\r\n<\/tr>\r\n<\/tbody>\r\n<\/table>\r\n<\/div>\r\n \r\n\r\nYou have calculated the payback at 4 years:\r\n
\r\n\r\n\r\n\r\n\r\n\r\n\r\n\r\n\r\n\r\n\r\n\r\n\r\n\r\n
Description<\/th>\r\nAmount<\/th>\r\n<\/tr>\r\n<\/thead>\r\n
Cost of new machine<\/td>\r\n$\u00a0 \u00a0 \u00a0 230,000<\/td>\r\n<\/tr>\r\n
Recaptured YR 1<\/td>\r\n$ \u00a0 \u00a0 (60,000)<\/td>\r\n<\/tr>\r\n
Left to recapture<\/td>\r\nSingle Line<\/span>$\u00a0 \u00a0 \u00a0 170,000<\/td>\r\n<\/tr>\r\n
Recaptured YR 2<\/td>\r\n$ \u00a0  \u00a0(60,000)<\/td>\r\n<\/tr>\r\n
Left to recapture<\/td>\r\nSingle Line<\/span>$\u00a0 \u00a0 \u00a0 110,000<\/td>\r\n<\/tr>\r\n
Recaptured YR 3<\/td>\r\n$ \u00a0 \u00a0 (55,000)<\/td>\r\n<\/tr>\r\n
Left to recapture<\/td>\r\nSingle Line<\/span>$\u00a0 \u00a0    55,000<\/td>\r\n<\/tr>\r\n
Recaptured YR 4<\/td>\r\n$ \u00a0 \u00a0 (55,000)<\/td>\r\n<\/tr>\r\n
Left to recapture<\/td>\r\nSingle Line<\/span>$\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 -<\/td>\r\n<\/tr>\r\n<\/tbody>\r\n<\/table>\r\n<\/div>\r\n \r\n\r\nAnd the accounting rate of return:\r\n
\r\n\r\n\r\n\r\n\r\n\r\n\r\n\r\n\r\n\r\n\r\n\r\n\r\n\r\n\r\n\r\n\r\n
Accounting Rate of Return (ARR)<\/caption>\r\n
Description<\/th>\r\nAmount<\/th>\r\n<\/tr>\r\n<\/thead>\r\n
Total net cash inflows<\/td>\r\n$\u00a0 \u00a0 \u00a0 345,000<\/td>\r\n<\/tr>\r\n
Depreciation on machine<\/td>\r\n$\u00a0 \u00a0 \u00a0 190,000<\/td>\r\n<\/tr>\r\n
Accounting income<\/td>\r\nSingle Line<\/span>$\u00a0 \u00a0 \u00a0 155,000<\/td>\r\n<\/tr>\r\n
Operating life in years<\/td>\r\n6<\/td>\r\n<\/tr>\r\n
Average annual operating income<\/td>\r\nSingle Line<\/span>$ \u00a0 \u00a0 \u00a0 25,833<\/td>\r\n<\/tr>\r\n
<\/td>\r\n<\/td>\r\n<\/tr>\r\n
Investment<\/td>\r\n$ \u00a0 \u00a0  230,000<\/td>\r\n<\/tr>\r\n
Residual value<\/td>\r\n$ \u00a0 \u00a0 \u00a0 40,000<\/td>\r\n<\/tr>\r\n
Net investment (depreciable value)<\/td>\r\nSingle Line<\/span>$ \u00a0 \u00a0  190,000<\/td>\r\n<\/tr>\r\n
Divided by:<\/td>\r\n2<\/td>\r\n<\/tr>\r\n
Average amount invested<\/td>\r\nSingle Line<\/span>$\u00a0 \u00a0 \u00a0 \u00a095,000<\/td>\r\n<\/tr>\r\n
<\/td>\r\n<\/td>\r\n<\/tr>\r\n
Accounting rate of return<\/td>\r\n27.19%<\/td>\r\n<\/tr>\r\n<\/tbody>\r\n<\/table>\r\n<\/div>\r\n \r\n\r\nSo far, this project has made it through all of the internal screening processes and is now at the highest levels for approval. Upper management is now asking for a more sophisticated analysis. The CEO and CFO and the capital planning team would like to know the net present value of the project as well as the internal rate of return, along with a profitability index. They have set a hurdle rate of 15% based on the company\u2019s WACC (weighted average cost of capital). Let\u2019s walk through creating this analysis.\r\n\r\nWhen you are done with this section, you will be able to:\r\n